oversight

Rural Development: Rural Business--Cooperative Service's Lending and the Financial Condition of Its Loan Portfolio

Published by the Government Accountability Office on 1999-01-12.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to the Chairman, Committee on
                 Agriculture, House of Representatives



January 1999
                 RURAL
                 DEVELOPMENT
                 Rural Business-
                 Cooperative Service’s
                 Lending and the
                 Financial Condition of
                 Its Loan Portfolio




GAO/RCED-99-10
                       United States
GAO                    General Accounting Office
                       Washington, D.C. 20548

                       Resources, Community, and
                       Economic Development Division

                       B-281089

                       January 12, 1999

                       The Honorable Larry Combest
                       Chairman, Committee on Agriculture
                       House of Representatives

                       Dear Mr. Chairman:

                       The Rural Business-Cooperative Service (RBS) of the U.S. Department of
                       Agriculture (USDA) operates a variety of loan programs that assist in the
                       business development of the nation’s rural areas and in the employment of
                       rural residents. Specifically, the agency’s

                   •   business and industry loan program guarantees loans made by private
                       lenders and makes direct government-funded loans at market interest
                       rates to finance business projects that create or retain jobs in rural areas,
                   •   intermediary relending program makes direct loans at a 1-percent interest
                       rate for financing revolving funds from which borrowers relend the money
                       for business and community development projects, and
                   •   rural economic development program makes interest-free direct loans for
                       relending for business and economic development projects.

                       This report provides information on the Rural Business-Cooperative
                       Service’s lending. In particular, we are providing information on (1) the
                       number and dollar value of loans approved by the agency, (2) the federal
                       government’s costs associated with the agency’s loans, and (3) the
                       financial condition of the agency’s loan portfolio, including the losses
                       incurred.1 We also are providing information on the geographic dispersion
                       of these loans and the level of pending applications for guaranteed
                       business and industry loans. The information on the number and dollar
                       value of loans, the financial condition of the portfolio, and loan losses
                       covers 5.5 fiscal years—including fiscal 1993 through the first half of fiscal
                       1998 (Mar. 31, 1998). The information on the federal government’s cost of
                       these loan programs is based on USDA’s cost estimates and covers fiscal
                       year 1993 through fiscal 1997, the year of the latest cost information
                       readily available when we conducted our work.


                       The Rural Business-Cooperative Service approved more than 2,900 rural
Results in Brief       business loans during fiscal year 1993 through the first 6 months of fiscal


                       1
                        RBS operates loan programs formerly administered by other USDA agencies. In this report, we refer
                       to these loans and programs as RBS’ loans and programs.



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             1998; these loans totaled about $3.2 billion. More than three quarters of
             these loans and almost 90 percent of the total loan amount were
             guaranteed business and industry loans; only 2 percent of the loans were
             direct government-funded business and industry loans. The remaining
             loans were direct loans under the intermediary relending program and the
             rural economic development program.

             The estimated total cost of these loan programs was about $290 million
             during fiscal year 1993 through fiscal 1997. Of this amount, the subsidy
             costs of the loans, which primarily involve the estimates of default costs
             and interest rate subsidies, were almost $195 million. Administrative costs,
             which cover estimates of salaries and other expenses associated with
             operating the programs, totaled about $95 million.

             As of March 31, 1998, the unpaid principal on the Rural
             Business-Cooperative Service’s outstanding guaranteed and direct loans
             totaled about $2.2 billion. Delinquent borrowers (those that are at least 30
             days past due on scheduled payments) held about
             $116 million—$112 million on guaranteed business and industry loans and
             about $4 million on direct business and industry loans and intermediary
             relending loans—or 5.4 percent of the total outstanding principal.
             Furthermore, from the start of fiscal year 1993 through March 31, 1998, the
             agency incurred loan losses totaling about $266 million: about $264 million
             on guaranteed business and industry loans and about $2 million on
             intermediary relending loans. The agency did not experience any losses on
             debt associated with direct business and industry loans or with rural
             economic development loans.


             RBS operates loan programs that are intended to assist in the business
Background   development of the nation’s rural areas and the employment of rural
             residents. Within USDA, RBS is located in the Rural Development (RD)
             mission area. The agency’s national office in Washington, D.C., provides
             policy direction and guidance on the loan making and servicing aspects of
             the programs, and reviews and approves certain loans. Many of the loan
             making and servicing functions are performed by RD mission area staff
             who are physically located in field offices throughout the country.2

             RBS operates the following loan programs: the business and industry (B&I)
             program, the intermediary relending program (IRP), and the rural economic

             2
              In this report, we refer to the RD mission area’s field offices and staffs who operate RBS’ loan
             programs as the agency’s field offices and staffs.



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development (RED) program. The following is a general description of each
program.

B&I  loans. A B&I loan can be either a direct government-funded loan or a
loan made by another lender on which RBS guarantees repayment in the
event of a loss. These loans are made to finance almost any business
project that creates or retains jobs in rural areas and to finance projects in
all segments of the economy, such as mining, manufacturing, and
wholesale and retail sales. There are only a few activities for which B&I
loans cannot be used, such as funding gambling facilities, race tracks, and
golf courses. Additionally, RBS’ regulations, which, according to the
agency’s officials, are being revised, provide that direct B&I loans cannot be
used for constructing hotels and motels, and tourism and recreational
facilities. However, guaranteed B&I loans can be used for those purposes.
The interest rate on a direct loan is based on the prime rate that was in
effect in the quarter of a year prior to the quarter in which the loan is
made. The interest rate on a guaranteed loan is the rate agreed to by the
lender making the loan and the borrower. According to RBS officials, this
rate is generally the lender’s prime rate—the rate a lender charges its best
customers—plus 1 to 1.5 additional percentage points.

IRP loans. IRP loans are direct government-funded loans made for relending,
mostly to nonprofit community development organizations, and, to a
lesser extent, to other borrowers, such as for-profit and nonprofit
cooperatives. Specifically, the IRP loan funds are deposited into a revolving
fund that an RBS borrower—an intermediary—has established. The
intermediary relends the money to its borrowers—which may be
individuals, public or private organizations, or any other legal entity—for
financing business or community development projects in rural areas. IRP
loan funds are not allowed for certain purposes, including funding
gambling facilities, race tracks, and golf courses. RBS’ approval is required
for the intermediary’s relending of the IRP loan funds. RBS charges its
borrowers a 1-percent interest rate on IRP loans. The interest rate on a loan
from the revolving fund is the rate agreed to by the intermediary and its
borrower. RBS does not specify what this rate should be.

RED loans. RED loans are also direct loans made for relending. The loans are
made only to borrowers that have outstanding electricity or
telecommunications loans from USDA’s Rural Utilities Service (RUS) and to
former RUS borrowers that repaid their electricity loans early at a discount.
Unlike IRP loans, a RED loan, when approved, is targeted to a specific
project. The RED loan funds are deposited into a fund that the RUS



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                            borrower has established. The RUS borrower relends the money to other
                            borrowers, which may be any public or private organization or other legal
                            entity, for an economic development and job creation project. These
                            projects include new business creation, existing business expansion,
                            community improvements, and infrastructure development. RED loan funds
                            cannot be used for certain purposes, including the RUS borrowers’
                            electricity or telecommunications operations or a community’s television
                            system or facility, unless tied to an educational or medical project. RED
                            loans are interest free, and RBS requires that loan funds be relent interest
                            free.

                            (App. I provides more descriptive information on each of RBS’ loan
                            programs.)


                            RBS approved more than 2,900 rural business loans during fiscal year 1993
Increasing Total            through the first half of fiscal 1998.3 The total amount of these loans was
Volume and Value of         more than $3.2 billion,4 or approximately $1.1 million, on average, per
Loans in Recent Years       loan. Specifically, RBS approved the following loans during this 5.5-year
                            period:

                        •   2,299 guaranteed B&I loans totaling almost $2.9 billion and averaging
                            $1.2 million, and 58 direct B&I loans totaling about $17 million and
                            averaging about $300,000 and
                        •   315 IRP loans totaling about $280 million and averaging about $900,000, and
                            256 RED loans totaling about $70 million and averaging about $275,000.

                            The total number and value of rural business loans approved by RBS
                            increased during these years. In fiscal year 1993, RBS approved 298 loans
                            totaling about $234 million, while in fiscal 1997, it approved 788 loans
                            totaling $878 million. Most of the increase in loans stems from increases in
                            guaranteed B&I loans, which rose by almost 250 percent over this period.


Large Increase in           At almost $2.9 billion, guaranteed B&I loans constituted the largest
Guaranteed B&I Loan         category of loans approved by RBS during the period of fiscal year 1993
Activity                    through March 31, 1998. Furthermore, the level of guaranteed B&I loan
                            activity increased substantially during this 5.5-year period. For example,
                            RBS approved 190 guaranteed B&I loans in fiscal year 1993 with a total value


                            3
                             In this section of the report, loans approved refers to those loans on which obligations were
                            established in USDA’s financial records.
                            4
                             The total dollar amount of loans in constant 1998 dollars is about $3.4 billion.



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                                         of more than $187 million. As table 1 shows, this compares with 663 loans
                                         in fiscal year 1997 and 377 loans in the first half of fiscal 1998, which have
                                         total values of more than $816 million and about $540 million, respectively.


Table 1: Number and Dollar Amount of Guaranteed B&I Loans Approved by RBS, Fiscal Year 1993 Through the First Half of
Fiscal Year 1998
Loan information         1993a           1994         1995           1996         1997b           1998b              Total
Number of loans             190              179             327                  563              663                     377         2,299
Total dollar amount
of loans (in millions)   $187.4         $249.6           $423.6               $638.4            $816.3              $539.6           $2,854.9c
Average dollar
amount of loans (in
thousands)                $986          $1,394           $1,295               $1,134            $1,231              $1,431            $1,242
Dollar range of
loans (in                 $22 to         $57 to           $20 to               $24 to             $8 to              $62 to            $8 to
thousands)               $5,350         $7,300           $9,000               $9,000            $9,000              $9,000            $9,000
                                         a
                                          Includes 94 loans totaling $87.4 million that were approved in fiscal year 1993 under an
                                         emergency supplemental appropriation authorization.
                                         b
                                          Includes 2 RBS guaranteed loans totaling approximately $900,000 that were approved in fiscal
                                         year 1997 and 12 loans totaling approximately $8 million that were approved in the first 6 months
                                         of fiscal 1998. These loans were made in conjunction with the North American Development Bank
                                         under the terms of the North American Free Trade Agreement.
                                         c
                                          The total dollar amount of loans in constant 1998 dollars is $2,964.5 million.

                                         Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                         Office.



                                         While guaranteed B&I loans were approved for borrowers in every state, a
                                         large number of the approved loans were concentrated in a few states.
                                         Specifically, 33 percent of the loans approved during this 5.5-year period
                                         were for borrowers in eight states; these loans accounted for 38 percent of
                                         the $2.9 billion loan amount. In each of the top three states—California,
                                         Florida, and North Carolina—more than 100 loans were approved. In total,
                                         400 loans with a total value of approximately $508 million were approved
                                         in these three states.

Level of Pending Applications            On top of the rapid growth in guaranteed B&I loans, RBS reported, in its
                                         appropriation request for fiscal year 1999, having a large amount—about
                                         $935 million—of pending guaranteed B&I loan requests as of September 30,
                                         1997. However, our review disclosed that many of these requests were not
                                         ready to be approved or funded. Specifically, a large part of the backlog
                                         consisted of preapplications for loans; these are cases in which lenders
                                         expressed an interest in applying for loans and submitted some



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                                          documentation but had not submitted formal applications. There were 363
                                          preapplications, which accounted for about 71 percent of the more than
                                          500 requests reported as pending and about 72.5 percent of the total loan
                                          amount. These preapplications included 166 cases in which the
                                          preapplicants had been told to develop and submit an application;
                                          however, in 60 cases, the notifications to submit applications were more
                                          than 6 months old, including some that were almost 3 years old.

                                          Additionally, in mid-1998, RBS found that 127 loan requests
                                          (preapplications and applications) that it had on hand, which totaled
                                          $259.6 million, were inactive. An inactive loan request is one in which,
                                          among other things, additional information that had been requested from
                                          the lender and/or the borrower had not been provided; the loan request
                                          would not be approved because, for example, the project as proposed was
                                          not eligible for loans in the program; or the borrower no longer wanted the
                                          loan.


Relatively Few Direct B&I                 RBS’ experience with direct B&I loans is quite different from its experience
Loans Were Made                           with guaranteed B&I loans. Specifically, RBS did not approve any direct
                                          loans during fiscal years 1993 through 1996 because USDA’s appropriation
                                          acts did not authorize it to do so. However, as table 2 shows, in fiscal year
                                          1997 and the first half of fiscal 1998, the agency approved 58 loans valued
                                          at $17.2 million.

Table 2: Number and Dollar Amount of
Direct B&I Loans Approved by RBS,         Loan information                                 1997                    1998                Total
Fiscal Year 1997 Through the First Half   Number of loans                                     33                        25               58
of Fiscal Year 1998
                                          Total dollar amount of
                                          loans (in millions)                             $12.4                     $4.8               $17.2a
                                          Average dollar amount of
                                          loans (in thousands)                             $376                    $191                $296
                                          Dollar range of loans (in                       $50 to                   $6 to            $6 to
                                          thousands)                                     $2,100                    $500            $2,100
                                          a
                                          The total dollar amount of loans in constant 1998 dollars is $17.4 million.

                                          Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                          Office.



                                          The direct B&I loans that RBS approved during this 1.5-year period were for
                                          borrowers located in 24 states, Puerto Rico, and the Western Pacific
                                          Islands. Five states and Puerto Rico accounted for 60 percent of the loans




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                                          and 52 percent of the loan obligations. Missouri was the top state in terms
                                          of the number of loans—12—and Puerto Rico had the highest dollar
                                          amount of loans—$2.5 million. The other four states were Arkansas,
                                          Hawaii, South Carolina and Texas.


IRP Loan Activity Mixed                   IRPloans accounted for the second largest category of loans that RBS
                                          approved during fiscal year 1993 through the first half of fiscal 1998. Fiscal
                                          year 1995 was the peak year for IRP loans, when 89 loans, which totaled
                                          more than $85 million, were approved. Since then, as table 3 shows, the
                                          total value of IRP loans approved each year has declined.


Table 3: Number and Dollar Amount of IRP Loans Approved by RBS, Fiscal Year 1993 Through the First Half of Fiscal Year
1998
Loan information          1993            1994        1995             1996         1997             1998              Total
Number of loans              43                 71            89                   47                53                   12            315
Total dollar amount
of loans (in millions)    $33.7           $77.4            $85.2               $37.6             $37.2                   $8.2      $279.2a
Average dollar
amount of loans (in
thousands)                 $784          $1,090            $957                 $801              $701                   $683          $886
Dollar range of
loans (in                $250 to        $250 to           $50 to             $200 to           $140 to              $200 to         $50 to
thousands)                $1,300         $2,000          $2,000               $2,000            $2,000               $1,000        $2,000
                                          a
                                          The total dollar amount of loans in constant 1998 dollars is $297.5 million.

                                          Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                          Office.



                                          Many of the IRP loans were for borrowers in only a few of the 43 states,
                                          Puerto Rico, and the U.S. Virgin Islands, where loans were approved.
                                          Specifically, 109 of the 315 loans, or almost 35 percent, were for borrowers
                                          in six states. These 109 loans totaled over $106 million, which is over 38
                                          percent of the total value of all IRP loans approved during this 5.5-year
                                          period. Two states—Minnesota and Oregon—accounted for 51 of these
                                          loans and $50.9 million. The other four states, which accounted for 58
                                          loans and $55.6 million, were Arkansas, California, Maine, and Mississippi.


RED Loans Have Been                       RED loans ranked third in terms of the number of loans and value approved
Decreasing                                during fiscal year 1993 through the first half of fiscal 1998. The number of
                                          RED loans approved declined each year during this period, from 65 loans in




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                                         fiscal year 1993 to 39 in fiscal 1997, and to 19 in the first half of fiscal 1998.
                                         However, as table 4 shows, the total dollar value of loans was relatively
                                         stable, ranging from more than $12 million to $13.5 million for the full
                                         fiscal years during the period.


Table 4: Number and Dollar Amount of RED Loans Approved by RBS, Fiscal Year 1993 Through the First Half of Fiscal Year
1998
Loan information          1993           1994        1995            1996          1997             1998             Total
Number of loans             65                 46             45                   42                39                  19             256
Total dollar amount
of loans (in millions)   $12.4           $13.5             $12.3                $13.1            $12.3                  $6.8          $70.4a
Average dollar
amount of loans (in
thousands)                $191               $293          $274                 $312              $315                  $359           $275
Dollar range of
loans (in                $36 to          $50 to           $24 to               $80 to           $21 to              $100 to           $21 to
thousands)                $400            $400             $400                 $400             $400                 $750             $750
                                         a
                                          The total dollar amount of loans in constant 1998 dollars is $74.5 million.

                                         Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                         Office.



                                         RBS approved a total of 256 RED loans for 192 borrowers during this
                                         5.5-year period; these borrowers were located in 32 states. A majority of
                                         the loans—136 loans, or 53.1 percent—were for borrowers in six states:
                                         Minnesota, Tennessee, North Dakota, Kansas, Iowa, and Wisconsin. The
                                         loans to these borrowers accounted for $34.2 million, or slightly less than
                                         half—48.6 percent—of the total loan obligations.

                                         Additionally, some borrowers had both RED and IRP loans approved from
                                         the start of fiscal year 1993 through March 31, 1998. Specifically, eight
                                         borrowers had 13 RED loans, valued at about $4.1 million, approved during
                                         this period; these borrowers also had 9 IRP loans, valued at about
                                         $7.9 million, approved. This occurred because RED and IRP loans are both
                                         available to certain nonprofit cooperatives for relending purposes.




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                                         RBS’estimated cost for the business loan programs totaled about
Subsidies Account for                    $290 million during fiscal year 1993 through fiscal 1997. The cost of
a Large Part of RBS’                     operating a federal credit program consists of two components: subsidy
Costs of Operating the                   costs, which involve the estimates of default costs, interest rate subsidies,
                                         fees, and other costs and revenues; and administrative costs, which cover
Loan Programs                            salaries and other expenses.5

                                         About $195 million of RBS’ total costs was the agency’s estimated subsidy
                                         costs associated with its loans.6 In addition, as table 5 shows, RBS incurred
                                         an estimated $95 million in administrative costs associated with operating
                                         the loan programs.

Table 5: RBS’ Estimated Total Costs
for Rural Business Loans, Fiscal Years   Dollars in millions
1993-97                                                                                                Administrative
                                         Program and loan type                 Subsidy costs                   costs               Total costs
                                         B&I guaranteed                                   $30.0                   $85.5                  $115.5
                                         B&I direct                                          0.1                     0.7                     0.8
                                         IRP direct                                       148.4                      5.7                   154.1
                                         RED direct                                        16.2                      3.1                    19.3
                                         Total                                          $194.7                    $95.0                  $289.7
                                         Note: App. II provides annual information on the estimated subsidy and administrative costs of
                                         RBS’ loan programs in each of these 5 years.

                                         Source: Our calculation was based on information contained in USDA, Budget Explanatory Notes
                                         for Committee on Appropriations, fiscal years 1995-99, and estimates developed by us or
                                         provided by the Budget Division of USDA’s RD mission area.



                                         As shown in table 5, IRP loans, which had total costs exceeding
                                         $154 million for fiscal year 1993 through fiscal 1997, were the most
                                         expensive of the rural business loans that RBS provided. The estimated
                                         subsidy costs constituted most of the total costs for these loans, reflecting
                                         the high interest subsidy on IRP loans. Specifically, IRP loans are made at a
                                         1-percent interest rate, which is far below the agency’s cost of money. The
                                         overall subsidy rate for IRP loans over this 5-year period was 54.8 percent,

                                         5
                                          The Federal Credit Reform Act of 1990, which was included as title 13B of the Omnibus Budget
                                         Reconciliation Act of 1990 (P.L. 101-508, Nov. 5, 1990) changed the way post-fiscal year 1991 credit
                                         programs are reported in the budget by ensuring that their subsidy costs were considered in making
                                         resource allocation decisions. (App. II presents a further discussion of the principles and requirements
                                         of credit reform, which apply to post-fiscal year 1991 credit.)
                                         6
                                          We mostly used the subsidy cost information from USDA’s budget explanatory notes from the fiscal
                                         years 1995-99 appropriations requests, the best available subsidy cost information at the time of our
                                         review. However, USDA’s Office of Inspector General has issued a qualified opinion on the RD mission
                                         area’s financial statements and has reported continuing problems with support for the estimated
                                         subsidy costs of the loan programs.



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                       or about 55 cents per dollar of loan. This was the highest subsidy rate for
                       any of the rural business loan programs.

                       Guaranteed B&I loans were the second most expensive of RBS’ loans during
                       this period. Unlike the costs for IRP loans, the estimated administrative
                       costs accounted for a larger part of the total costs than the estimated
                       subsidy costs. This difference is in part explained by the fact that the
                       overall subsidy rate for guaranteed B&I loans is considerably lower than
                       the subsidy rate for IRP loans. More specifically, over this 5-year period, the
                       overall subsidy rate for these guaranteed loans was 1.3 percent, or more
                       than 1 cent per dollar of loan.

                       The costs associated with RED loans totaled $19.3 million, which included
                       $16.2 million of RBS’ estimated subsidy costs. At 25.5 percent, or about 26
                       cents per dollar of loan, the overall subsidy rate for RED loans over this
                       5-year period was second only to IRP loans. The subsidy costs of these
                       loans were funded with appropriated funds; since fiscal year 1997, the
                       subsidy costs of RED loans have been funded from earnings received on
                       advance payments made by RUS’ borrowers on their RUS loans.7

                       Lastly, RBS’ costs for direct B&I loans was small, reflecting the low level of
                       activity in the program during the 5-year period. Specifically, the estimated
                       costs totaled about $770,000; this total applies to the loans approved in
                       fiscal year 1997—there were no direct B&I loans approved during fiscal
                       year 1993 through fiscal 1996. RBS’ estimated subsidy costs for the fiscal
                       year 1997 loans was over $60,000. The subsidy rate for these loans was
                       0.5 percent, or less than 1 cent per dollar of loan.


                       The outstanding principal on RBS’ B&I, IRP, and RED loans totaled about $2.2
Delinquent Borrowers   billion as of March 31, 1998.8 Borrowers that were delinquent (at least 30
Mostly Have            days past due on loan repayment) held about $116 million, or 5.4 percent,
Guaranteed B&I         of the total outstanding principal. Of the $116 million, about $112 million
                       was held by delinquent borrowers with guaranteed B&I loans, about
Loans
                       7
                        The authority for the RED loan program provides that RUS’ borrowers can make advance payments to
                       USDA on their RUS loans and earn interest at a rate of 5 percent. To cover the costs of the RED loans,
                       RBS can use (1) the differential between the earnings on these advance payments and the 5-percent
                       interest or (2) appropriated funds. Earnings on the advance payments in excess of 5 percent reduce
                       the cost of these loans to the government.
                       8
                        The information in this section of the report discusses the outstanding principal on the loans made or
                       guaranteed by RBS. We have not adjusted the outstanding loan amounts to reflect the allowance for
                       losses that RBS includes in its financial statements. Also, while collateral property has been pledged as
                       security for the loans, we did not determine the extent to which such property protects the
                       government’s investments in the outstanding loans.



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                           $2 million was held by delinquent borrowers with direct B&I loans, and
                           another $2 million was held by delinquent borrowers holding IRP loans.
                           More of the outstanding principal on RBS’ loans is at risk, however,
                           because it is held by other borrowers that the agency’s officials have
                           identified as being problem borrowers, which include those likely to
                           default on loan repayment in the future. RBS’ records show that such
                           borrowers owed about $73.8 million on guaranteed B&I loans and over
                           $400,000 on IRP loans as of March 31, 1998.

                           Furthermore, RBS had written off some borrowers’ debts in recent years.
                           Specifically, the agency lost $263.8 million on guaranteed B&I loans during
                           fiscal year 1993 through March 31, 1998. The agency also wrote off about
                           $2 million on IRP loans during this period. The agency did not write off any
                           direct B&I loans or RED loans during this period.


Over $100 Million of       According to RBS’ automated files, over $112 million, or 6.1 percent of the
Guaranteed B&I Loans Are   more than $1.8 billion in outstanding principal on guaranteed B&I loans as
at Risk                    of March 31, 1998, was held by 76 borrowers that were delinquent. These
                           76 borrowers made up 5 percent of the 1,534 total borrowers having
                           guaranteed B&I loans.

                           As table 6 shows, there has been a reduction in the amount of principal
                           owed by delinquent borrowers and in the number of delinquent borrowers
                           each year during fiscal year 1993 through the first half of fiscal 1998.




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Table 6: Amount of Outstanding Principal Owed on Guaranteed B&I Loans and Portion Owed by Delinquent Borrowers,
September 30, 1993, Through September 30, 1997, and March 31, 1998
Dollars in millions
Guaranteed B&I loans                1993               1994               1995                1996                 1997                1998
Amount of outstanding
principal
Owed by all borrowers           $1,000.4              $942.8            $990.1            $1,180.8            $1,615.8            $1,828.7
Owed by delinquent borrowers      $224.9              $174.9            $150.9              $128.6              $128.3               $112.3
Percentage owed by
delinquent borrowers                22.5                18.6               15.2                10.9                  7.9                   6.1
Dollar range of outstanding        <$0.1              <$0.1              <$0.1               <$0.1               <$0.1               <$0.1
principal owed by delinquent          to                  to                 to                  to                  to                  to
borrowersa                         $17.1               $11.5              $11.5               $11.5               $17.4               $11.5
Number of borrowers
Having outstanding principal       1,043                955                 942               1,053               1,348               1,534
That were delinquent                 145                121                 108                  95                  78                    76
Percentage that were
delinquent                          13.9                12.7               11.5                 9.0                  5.8                   5.0
                                           a
                                         The low end of the range for each year is as follows: about $4,300 for 1993, $5,700 for 1994,
                                        $13,800 for 1995, $5,400 for 1996, $13,000 for 1997, and $4,500 for 1998 (dollars are not stated
                                        in millions).

                                        Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                        Office.



                                           Many of the loans held by delinquent borrowers were made in recent
                                           years. Specifically, as of March 31, 1998, these borrowers were past due on
                                           principal and/or interest payments on 47 loans that were made during the
                                           1990s—17 from fiscal year 1990 through 1993 and 30 from fiscal year 1994
                                           through 1997.

                                           A small number of borrowers in a few states accounted for a
                                           disproportionate share of the outstanding principal on guaranteed B&I
                                           loans held by delinquent borrowers. Specifically, a total of 12 delinquent
                                           borrowers in four states—Mississippi, North Dakota, New York, and
                                           Louisiana—owed about $55 million of outstanding principal on 17 loans,
                                           or almost 50 percent of the amount owed by all delinquent borrowers, as
                                           of March 31, 1998.

                                           In addition to the delinquent borrowers, 56 other borrowers were
                                           identified by the agency’s field office officials as being problem borrowers
                                           as of March 31, 1998; these borrowers owed about $73.8 million in




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                        B-281089




                        outstanding principal on guaranteed B&I loans. Specifically, the field office
                        officials reported that 51 borrowers were not in full compliance with the
                        terms and conditions of their loans or that they expect noncompliance to
                        occur in the future. RBS officials said the agency anticipates that some of
                        these borrowers will likely default on scheduled loan payments. This
                        assessment was made on the basis of information provided by the lenders
                        that made the loans and/or the borrowers. These 51 borrowers owed about
                        $69.3 million as of March 31, 1998. Additionally, the field office officials
                        reported that another five borrowers were involved in liquidation and/or
                        bankruptcy proceedings; these borrowers owed about $4.5 million as of
                        March 31, 1998.

                        Borrowers that failed to repay their guaranteed B&I loans caused RBS to
                        incur losses of $263.8 million during fiscal year 1993 through March 31,
                        1998. Specifically, RBS incurred losses on guaranteed B&I loans for 169
                        borrowers during this 5.5-year period. Generally, the loans on which these
                        losses were incurred had been made many years ago—as far back as the
                        1970s. However, the agency has experienced some losses on newer loans.
                        For example, as of July 24, 1998, RBS lost $24.2 million on 53 loans that had
                        closed since the start of fiscal year 1990, including losses of $6.6 million on
                        15 loans closed since fiscal 1993.


Some Direct B&I Loans   The outstanding principal owed by 27 borrowers with direct B&I loans
Are at Risk             totaled $10.1 million as of March 31, 1998. Of this amount, as table 7
                        shows, two delinquent borrowers owed principal of $1.8 million, or
                        17.4 percent.




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                                         B-281089




Table 7: Amount of Outstanding Principal Owed on Direct B&I Loans and Portion Owed by Delinquent Borrowers,
September 30, 1993, Through September 30, 1997, and March 31, 1998
Dollars in millions
Direct B&I loans                    1993               1994               1995                1996               1997                 1998
Amount of outstanding
principal
Owed by all borrowers                $7.0              $5.8                $5.1               $4.3                $4.7                $10.1
Owed by delinquent borrowers         $0.6                $0                  $0               $1.3                $1.3                 $1.8
Percentage owed by
delinquent borrowers                  8.4                  0                  0               29.8                27.4                 17.4
Dollar range of outstanding                                                                   $0.4                $0.4                 $0.9
principal owed by delinquent                                                                  and                 and                  and
borrowers                            $0.6                $0                  $0               $0.9                $0.9                 $0.9
Number of borrowers
Having outstanding principal          14                 13                  11                   8                 12                  27
That were delinquent                   1                   0                  0                   2                  2                   2
Percentage that were
delinquent                            7.1                  0                  0               25.0                16.7                  7.4
                                         Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                         Office.



                                         Concerning the two delinquent borrowers, one, located in Kentucky, owed
                                         slightly more than $900,000 on two loans that had been made in the early
                                         1980s. The other, located in Oregon, owed about $850,000 on a loan made
                                         in mid-1997.

                                         According to RBS-provided information, the agency’s field office officials
                                         have not identified any nondelinquent borrowers as being problem
                                         borrowers as of March 31, 1998. Also, RBS did not write off the debt of any
                                         direct B&I loan borrowers during fiscal year 1993 through March 31, 1998.


Few Problems Exist With                  The outstanding principal on IRP loans totaled $268.5 million as of
IRP Loans                                March 31, 1998. As table 8 shows, $1.9 million, or less than 1 percent, was
                                         owed by three borrowers that were delinquent.




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                                           B-281089




Table 8: Amount of Outstanding Principal Owed on IRP Loans and Portion Owed by Delinquent Borrowers, September 30,
1993, Through September 30, 1997, and March 31, 1998
Dollars in millions
IRP loans                           1993                 1994               1995                1996               1997                 1998
Amount of outstanding principal
Owed by all borrowers             $154.6               $220.7             $268.8              $275.2             $272.0             $268.5
Owed by delinquent borrowers        $3.2                 $3.2                $3.2               $2.8                $1.9                $1.9
Percentage owed by
delinquent borrowers                  2.1                  1.5                1.2                 1.0                0.7                 0.7
Dollar range of outstanding         $0.5                 $0.5                $0.5               $0.5                $0.5                $0.5
principal owed by delinquent          to                   to                  to                 to                  to                  to
borrowers                           $1.2                 $1.2                $1.2               $0.9                $0.7                $0.7
Number of borrowers
Having outstanding principal         157                  220                275                 308                330                 331
That were delinquent                   4                     4                  4                   4                  3                    3
Percentage that were
delinquent                            2.5                  1.8                1.5                 1.3                0.9                 0.9
                                           Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                           Office.



                                           The three borrowers that were delinquent at the end of March 1998 had
                                           loans made by the Department of Health and Human Services before the
                                           transfer of the IRP loan program and portfolio to USDA.9 Specifically, a
                                           delinquent borrower in Michigan owed $700,000 of outstanding principal
                                           on a loan made in 1983. Two other delinquent borrowers had outstanding
                                           loans that were made from 1980 through 1983—a Louisiana borrower
                                           owed about $673,000, and a Washington State borrower owed about
                                           $550,000.

                                            In addition to the delinquent borrowers, one other borrower had been
                                            identified by the agency’s field office officials as being a problem borrower
                                            as of March 31, 1998. This borrower, which received a loan in 1989, owed
                                            about $416,000 in outstanding principal.

                                           RBS experienced losses on two IRP loans during fiscal year 1993 through
                                           March 31, 1998. Specifically, in November 1992, the agency wrote off about
                                           $1.2 million that was owed by a borrower in Puerto Rico and, in
                                           February 1997, about $1 million owed by a borrower in Florida. Both these



                                           9
                                            The IRP loan program was transferred from the Department of Health and Human Services to USDA
                                           by section 1323 of the Food Security Act of 1985 (P.L. 99-198, Dec. 23, 1985).



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                                        B-281089




                                        write-offs involved loans that had been made by the Department of Health
                                        and Human Services in the 1980s.


No Problems Identified                  The outstanding principal on RED loans totaled $47.6 million as of
With RED Loans                          March 31, 1998. There were no delinquencies on these loans.10 Table 9
                                        shows the outstanding principal on RED loans at the end of fiscal year 1993
                                        through March 31, 1998.


Table 9: Amount of Outstanding Principal Owed on RED Loans, September 30, 1993, Through September 30, 1997, and
March 31, 1998
Dollars in millions
RED loans                           1993              1994                1995                1996                 1997                1998
Amount of outstanding
principal                          $17.1             $29.8                $38.6               $41.5               $43.9               $47.6
Number of borrowers
having outstanding principal         176               215                  231                 246                 252                 260
                                        Source: RBS’ loan reports and GAO’s analysis of records from the RD mission area’s Finance
                                        Office.



                                        No RED loan borrower had been identified by the agency’s field office
                                        officials as being a problem borrower as of March 31, 1998. Also, RBS did
                                        not write off the debt of any RED loan borrowers during fiscal year 1993
                                        through March 31, 1998.


                                        We provided USDA with a draft of this report for review and comment. USDA
Agency Comments                         made a number of technical comments and suggested several adjustments
                                        to the financial information in the report. We incorporated these
                                        comments and suggestions as appropriate. USDA’s comments and our
                                        response are in appendix III.


                                        We performed our review of RBS’ business loan programs from May
                                        through October 1998 in accordance with generally accepted government
                                        auditing standards. Our scope and methodology are discussed in appendix
                                        IV.



                                        10
                                          We do not include as delinquent those RED loan borrowers that are shown in the Finance Office’s
                                        reports as being past due on repayments when the delinquency was due to billing, payment, or
                                        administrative errors.



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B-281089




As agreed, unless you publicly announce its contents earlier, we plan no
further distribution of this report until 30 days from the date of this letter.
At that time, we will send copies of this report to the appropriate Senate
and House committees; interested Members of Congress; the Secretary of
Agriculture; the Administrator of RBS; the Director, Office of Management
and Budget; and other interested parties. We will also make copies
available to others upon request.

Please call me at (202) 512-5138 if you or your staff have any questions
about this report. Major contributors to this report are listed in appendix
V.

Sincerely yours,




Robert E. Robertson
Associate Director, Food
  and Agriculture Issues




Page 17                                  GAO/RCED-99-10 RBS’ Rural Business Loans
Contents



Letter                                                                                             1


Appendix I                                                                                        20
                        B&I Loans                                                                 20
Descriptive             IRP Loans                                                                 21
Information on the      RED Loans                                                                 22
Rural
Business-Cooperative
Service’s Loan
Programs
Appendix II                                                                                       24
                        RBS’ Costs for Operating the Rural Business Loan Programs                 24
Subsidy and             Credit Reform                                                             25
Administrative Costs
of RBS’ Loan
Programs
Appendix III                                                                                      27
Comments From
USDA
Appendix IV                                                                                       32
Objectives, Scope,
and Methodology
Appendix V                                                                                        34
Major Contributors to
This Report
Tables                  Table 1: Number and Dollar Amount of Guaranteed B&I Loans                  5
                          Approved by RBS, Fiscal Year 1993 Through the First Half of
                          Fiscal Year 1998




                        Page 18                              GAO/RCED-99-10 RBS’ Rural Business Loans
Contents




Table 2: Number and Dollar Amount of Direct B&I Loans                       6
  Approved by RBS, Fiscal Year 1997 Through the First Half of
  Fiscal Year 1998
Table 3: Number and Dollar Amount of IRP Loans Approved by                  7
  RBS, Fiscal Year 1993 Through the First Half of Fiscal Year 1998
Table 4: Number and Dollar Amount of RED Loans Approved by                  8
  RBS, Fiscal Year 1993 Through the First Half of Fiscal Year 1998
Table 5: RBS’ Estimated Total Costs for Rural Business Loans,               9
  Fiscal Years 1993-97
Table 6: Amount of Outstanding Principal Owed on Guaranteed                12
  B&I Loans and Portion Owed by Delinquent Borrowers,
  September 30, 1993, Through September 30, 1997, and March 31,
  1998
Table 7: Amount of Outstanding Principal Owed on Direct B&I                14
  Loans and Portion Owed by Delinquent Borrowers, September
  30, 1993, Through September 30, 1997, and March 31, 1998
Table 8: Amount of Outstanding Principal Owed on IRP Loans                 15
  and Portion Owed by Delinquent Borrowers, September 30, 1993,
  Through September 30, 1997, and March 31, 1998
Table 9: Amount of Outstanding Principal Owed on RED Loans,                16
  September 30, 1993, Through September 30, 1997, and March 31,
  1998
Table II.1: RBS’ Subsidy Costs for Rural Business Loans, Fiscal            24
  Years 1993-97
Table II.2: RBS’ Administrative Costs for the Rural Business Loan          25
  Programs, Fiscal Years 1993-97
Table II.3: RBS’ Total Costs for the Rural Business Loan                   25
  Programs, Fiscal Years 1993-97




Abbreviations

B&I        business and industry (loans)
GAO        General Accounting Office
IRP        intermediary relending program (loans)
RBS        Rural Business-Cooperative Service
RD         Rural Development (mission area)
RED        rural economic development (loans)
RUS        Rural Utilities Service
USDA       U.S. Department of Agriculture


Page 19                               GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix I

Descriptive Information on the Rural
Business-Cooperative Service’s Loan
Programs
               The Rural Business-Cooperative Service (RBS), an agency within the U.S.
               Department of Agriculture’s (USDA) Rural Development mission area,
               operates loan programs that are intended to assist in the business
               development of the nation’s rural areas and the employment of rural
               residents. The agency was established by the Federal Crop Insurance
               Reform and Department of Agriculture Reorganization Act of 1994 (P.L.
               103-354, Oct. 13, 1994). This appendix provides information on RBS’ three
               loan programs: the business and industry (B&I) program, the intermediary
               relending program (IRP), and the rural economic development (RED)
               program.


               A B&I loan can be either a direct government-funded loan or a loan made
B&I Loans      by another lender on which RBS guarantees repayment in the event of a
               loss. These loans are made to finance almost any business project that
               creates or retains jobs in rural areas and to finance projects in all
               segments of the economy, such as mining, manufacturing, and wholesale
               and retail sales. There are only a few activities for which B&I loans cannot
               be used, such as funding gambling facilities, race tracks, and golf courses.
               Additionally, RBS’ regulations, which, according to the agency’s officials,
               are being revised, provide that direct B&I loans cannot be used for
               constructing hotels and motels, and tourism and recreational facilities.
               However, guaranteed B&I loans can be used for those purposes.

               Direct B&I loans are made to any legal entity, such as an individual
               operating a sole proprietorship, a cooperative, or a corporation, including
               local governmental bodies. The maximum loan currently allowed by RBS is
               $10 million, which is also the amount of outstanding debt that a direct loan
               borrower may owe. The interest rate on a direct loan is based on the prime
               rate that was in effect in the quarter of a year prior to the quarter in which
               the loan is made.

               Guarantees are provided on loans made by traditional lenders, such as
               commercial banks, and, to a lesser extent, on loans made by
               nontraditional lenders, which are entities using investment capital for
               lending and which are authorized by state law to engage in lending. The
               loans are made to most types of legal entities, including for-profit and
               nonprofit cooperatives, corporations, partnerships, individuals, public
               bodies, and Indian tribes. The maximum loan currently is $25 million,
               which is also a borrower’s maximum debt level. In addition, RBS provides
               the following guarantee percentages: 80 percent on loans of $5 million or
               less, 70 percent on loans between $5 million and $10 million, and 60



               Page 20                                 GAO/RCED-99-10 RBS’ Rural Business Loans
            Appendix I
            Descriptive Information on the Rural
            Business-Cooperative Service’s Loan
            Programs




            percent on loans of more than $10 million. However, a guarantee of up to
            90 percent can be provided on a loan of $10 million or less if RBS’
            Administrator approves the higher percentage. The interest rate on a
            guaranteed loan is the rate agreed to by the lender making the loan and the
            borrower. According to RBS officials, this rate is generally the lender’s
            prime rate plus 1 to 1.5 additional percentage points.

            A business financed with a B&I loan is required to be located in a rural
            area, which is one that can have a population of no more than 50,000.
            Section 310B of the Consolidated Farm and Rural Development Act, as
            amended (7 U.S.C. 1932), contains the basic authority for the B&I loan
            program.


            IRP loans are direct government-funded loans made mostly to nonprofit
IRP Loans   community development organizations, and, to a lesser extent, to for-profit
            and nonprofit cooperatives, public bodies, and Indian tribes. For example,
            some electricity cooperatives that borrow from USDA’s Rural Utilities
            Service (RUS) have obtained IRP loans. Individuals are not eligible to obtain
            IRP loans nor are for-profit commercial companies.


            All IRP loans are made for relending. Specifically, the IRP loan funds are
            deposited into a revolving fund that the RBS borrower—an
            intermediary—has established. The intermediary relends the money in the
            revolving fund to its borrowers, which may be individuals, public or
            private organizations, or any other legal entity. A recipient can use the
            funds it obtains from the revolving fund to finance just about any project
            related to business or community development in rural areas. IRP loan
            funds are not allowed for certain purposes, including funding gambling
            facilities, race tracks, and golf courses. RBS’ approval is required for the
            relending of the IRP loan funds.

            The maximum loan currently allowed is $2 million for the first loan that an
            IRPborrower obtains and $1 million per fiscal year for any subsequent
            loans. The maximum total IRP debt that a borrower can have outstanding is
            $15 million.

            RBS charges borrowers a 1-percent interest rate on all IRP loans. The
            interest rate on a loan from the revolving fund is the rate agreed to by the
            intermediary and its borrower. RBS does not specify what this rate should
            be; the agency’s regulations state that intermediary borrowers should
            charge the recipients the lowest rate necessary to cover the debt service



            Page 21                                 GAO/RCED-99-10 RBS’ Rural Business Loans
            Appendix I
            Descriptive Information on the Rural
            Business-Cooperative Service’s Loan
            Programs




            costs on outstanding IRP loans, a reserve for bad debts, and administrative
            costs. However, RBS does not track the rates charged by its borrowers to
            revolving fund recipients.

            An IRP borrower does not have to be located in a rural area to obtain a
            loan. The intermediary’s borrower, however, is to be located in a rural
            area, which, for this program, is an unincorporated area or an
            incorporated area that has a population of no more than 25,000. The basic
            authority for the IRP loan program is 42 U.S.C. 9812, as amended by section
            1323 of the Food Security Act of 1985 (P.L. 99-198, Dec. 23, 1985), as
            amended.


            RED loans, which are also direct loans, are made to entities that have
RED Loans   outstanding RUS electricity or telecommunications loans or to former RUS
            borrowers that repaid their electricity loans early at a discount. RED loans
            are not available to former RUS borrowers that repaid their loans with
            scheduled payments.

            All RED loans are made for relending, and the loan funds are targeted to a
            specific project. Specifically, the RED loan funds are deposited into a fund
            that the RUS borrower has established. The RUS borrower relends the
            money to other borrowers, which may be any public or private
            organization or other legal entity, for an economic development and job
            creation project. These projects include new business creation, existing
            business expansion, community improvements, and infrastructure
            development. RED loan funds cannot be used for certain purposes,
            including the RUS borrowers’ electricity or telecommunications operations
            or a community’s television system or facility, unless tied to an
            educational or medical project. RBS’ approval is required for the relending
            of the RED loan funds.

            The maximum RED loan in any year to an RBS borrower is 3 percent of the
            appropriated loan level for the year, rounded to the nearest $10,000. For
            example, the maximum RED loan in fiscal year 1998 is $750,000, which is 3
            percent of the $25 million appropriated loan level for the year. There is no
            maximum number of RED loans that an RBS borrower may receive nor a
            maximum debt level that an RBS borrower may accumulate.

            RED loans are interest free, and RBS requires that loan funds be relent
            interest free. However, RBS’ borrowers are allowed to charge a




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Appendix I
Descriptive Information on the Rural
Business-Cooperative Service’s Loan
Programs




loan-servicing fee equal to 1 percent of the unpaid principal owed on the
loan.

Section 313 of the Rural Electrification Act of 1936, as amended (7 U.S.C.
940c), which authorizes the RED loans, provides that RUS’ borrowers are
allowed to make advance payments to USDA on their RUS loans and to earn
interest at a rate of 5 percent on the advance payments. RBS is authorized
to use the differential between the earnings on these advance payments
and the 5-percent interest or to use other available funds to cover the costs
of the RED loans. Rather than allowing RBS to use the differential to cover
the subsidy costs of RED loans during fiscal years 1993 through 1997, the
Congress provided USDA with separate appropriations.

A rural area for a loan in the RED program parallels a rural area for an
initial RUS electricity loan, which is an area that has less than 2,500
residents. However, RBS officials said that a RED loan can be made for a
project that is located in an area that has a higher population level if the
project serves or provides employment for residents of an area that meets
the 2,500-population threshold.




Page 23                                 GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix II

Subsidy and Administrative Costs of RBS’
Loan Programs

                                          This appendix contains information on RBS’ estimated subsidy cost for
                                          loans made during fiscal year 1993 through fiscal 1997. The appendix also
                                          includes estimates of the administrative cost of operating each of the loan
                                          programs during these 5 fiscal years. Information that describes the credit
                                          reform procedures in the Federal Credit Reform Act of 1990 is also
                                          provided.


                                          Tables II.1 through II.3 contain information on RBS’ estimated subsidy cost
RBS’ Costs for                            for making and guaranteeing rural business loans and its estimated
Operating the Rural                       administrative costs for operating the business loan programs during fiscal
Business Loan                             year 1993 through fiscal 1997. For example, table II.1 shows that a large
                                          part of the estimated subsidy costs in each year were for IRP loans. Table
Programs                                  II.2 shows that the estimated administrative costs were highest with the
                                          guaranteed B&I loans. Table II.3 shows that RBS’ estimated costs totaled
                                          about $290 million.


Table II.1: RBS’ Subsidy Costs for Rural Business Loans, Fiscal Years 1993-97
Dollars in millions
Program and loan type                 1993                1994                 1995                1996                1997                   Total
B&I guaranteed                       $10.2                 $2.3                $4.0                $5.9                 $7.6              $30.0
B&I direct                               0                     0                   0                   0                 0.1                    0.1
IRP direct                            18.3                 44.5                46.0                22.4                 17.3              148.4
RED direct                             3.2                  3.4                  3.1                 3.7a                2.8                  16.2
Total                                $31.6                $50.3               $53.1               $32.0               $27.7              $194.7
                                          Note: Totals may not add because of rounding.
                                          a
                                             This amount was provided in USDA’s written comments on a draft of this report. (See app. III.)

                                          Source: Except as noted above, estimates contained in USDA, Budget Explanatory Notes for
                                          Committee on Appropriations, fiscal years 1995-99.




                                          Page 24                                               GAO/RCED-99-10 RBS’ Rural Business Loans
                                              Appendix II
                                              Subsidy and Administrative Costs of RBS’
                                              Loan Programs




Table II.2: RBS’ Administrative Costs for the Rural Business Loan Programs, Fiscal Years 1993-97
Dollars in millions
Program and loan type                 1993                  1994               1995                1996               1997                Total
B&I guaranteed                       $18.3a                $21.4               $14.9              $14.9b              $16.1b              $85.5
B&I direct                               0                      0                  0                   0                0.7b                   0.7
IRP direct                              0.5                   1.5                1.5                 1.5                0.7b                   5.7
                                          c
RED direct                              0.6                   0.6                0.6                 0.7                0.7                    3.1
Total                                $19.5                 $23.4               $16.9              $17.0               $18.2               $95.0
                                              Note: Totals may not add because of rounding.
                                              a
                                               This estimate is based on transfers from the Rural Development Insurance Fund program
                                              account to cover the salaries and expenses associated with various USDA rural credit programs.
                                              b
                                              These amounts are estimates provided by the Budget Division of USDA’s Rural Development
                                              mission area.
                                              c
                                              This estimate is based on an average for the succeeding 4 years.

                                              Source: Except as noted above, estimates contained in USDA, Budget Explanatory Notes for
                                              Committee on Appropriations, fiscal years 1995-99.




Table II.3: RBS’ Total Costs for the Rural Business Loan Programs, Fiscal Years 1993-97
Dollars in millions
Program and loan type                 1993                  1994               1995                1996               1997                Total
B&I guaranteed                       $28.5                 $23.7               $18.9              $20.7               $23.7              $115.5
B&I direct                               0                      0                  0                   0                0.8                    0.8
IRP direct                            18.8                  46.0                47.5               23.9                18.0               154.1
RED direct                              3.8                   4.0                3.7                 4.4                3.5                19.3
Total                                $51.1                 $73.7               $70.0              $49.0               $45.9              $289.7
                                              Note: Totals may not add because of rounding.

                                              Source: GAO’s calculation.




                                              The two key principles of credit reform contained in the Federal Credit
Credit Reform                                 Reform Act of 1990 center on the (1) definition of cost in terms of the
                                              present value of the estimated cash flow over the life of a credit
                                              instrument and (2) inclusion in the budget of the costs of credit programs
                                              before direct or guaranteed loans are made or modified.

                                              Credit reform requirements separate the government’s cost of extending
                                              or guaranteeing credit, called the subsidy cost, from administrative and



                                              Page 25                                           GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix II
Subsidy and Administrative Costs of RBS’
Loan Programs




unsubsidized program costs. Administrative expenses receive separate
appropriations; they are treated on a cash basis and reported separately in
the budget. The unsubsidized portion of a direct loan or loan guarantee is
expected to be recovered from the borrower.

The Credit Reform Act defines the subsidy cost of direct loans as the
present value of estimated loan disbursements, repayments of principal,
and payments of interest and other payments by or to the
government—over the loan’s life—after adjusting for projected defaults,
prepayments, fees, penalties, and other recoveries. It defines the subsidy
cost of loan guarantees as the present value of cash flows from estimated
payments by the government (for defaults and delinquencies, interest rate
subsidies, and other payments) minus estimated payments to the
government (for loan origination and other fees, penalties, and
recoveries). Permanent, indefinite appropriations are available should the
appropriated subsidy cost be less than the estimates in a later fiscal year.

Before credit reform, credit programs—like other programs—were
reported in the budget on a cash basis. As a result, it was difficult to make
appropriate cost comparisons between direct loan and loan guarantee
programs and between credit and noncredit programs. Credit programs
had different economic effects than most budget outlays, such as the
purchase of goods and services, income transfers, and grants. In the case
of direct loans, for example, the fact that the loan recipient was obligated
to repay the government over time meant that the budgetary impact of a
direct loan disbursement could be much less than other budget
transactions of the same dollar amount. This lower budgetary impact also
created a bias in favor of loan guarantees over direct loans. Loan
guarantees appeared to be free, while direct loans appeared to be
expensive because the budget did not recognize that at least some of the
loan guarantees would default and that some of the direct loans would be
repaid.

The Credit Reform Act changed this treatment for direct loans and loan
guarantees made on or after October 1, 1991.




Page 26                                    GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix III

Comments From USDA


Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




Now on p. 3.
See comment 1.

Now on p. 3.
See comment 1.

Now on p. 5.
See comment 2.




See comment 3.




                             Page 27   GAO/RCED-99-10 RBS’ Rural Business Loans
                 Appendix III
                 Comments From USDA




Now on p. 8.
See comment 4.



Now on p. 9.
See comment 5.




Now on p. 10.
See comment 1.


Now on p. 12.
See comment 6.




Now on p. 13.
See comment 7.


Now on p. 21.
See comment 1.

Now on p. 22.
See comment 1.



See comment 1.


Now on p. 24.
See comment 8.

See comment 5.




                 Page 28              GAO/RCED-99-10 RBS’ Rural Business Loans
                 Appendix III
                 Comments From USDA




See comment 9.




Now on p. 25.
See comment 5.

See comment 9.




                 Page 29              GAO/RCED-99-10 RBS’ Rural Business Loans
                 Appendix III
                 Comments From USDA




                 The following are GAO’s comments on USDA’s letter dated November 9,
                 1998.


                 1. The final report was revised to reflect USDA’s comment.
GAO’s Comments
                 2. USDA’s comment on the number and total dollar value of guaranteed B&I
                 loans approved in fiscal year 1993 overlooks 94 loans valued at
                 $87,401,900, which were approved under an emergency supplemental
                 appropriation authorization. These additional loans are contained in the
                 automated obligation records that we obtained from the Finance Office of
                 USDA’s Rural Development (RD) mission area and were reported in a USDA
                 appropriation request as having been approved in fiscal 1993. We have
                 added a note to table 1 stating that the fiscal year 1993 information
                 includes loans made under this emergency appropriation provision.

                 3. Our report is based on the automated obligation records that the RD
                 mission area’s Finance Office provided us for each fiscal year. These
                 automated records show that RBS obligated $421.6 million of guaranteed
                 B&I loans for fiscal year 1995. However, USDA commented that it obligated
                 $2 million more, for a total of $423.6 million. We rechecked the automated
                 records that we had been provided and did not identify additional
                 obligations totaling $2 million. Subsequently, officials in the Finance Office
                 said that the fiscal year 1995 automated record that we were provided did
                 not include adjustments that had been made to the agency’s master loan
                 file, which increased the total obligations by approximately $2 million. We
                 have adjusted the financial statistics on the guaranteed B&I loans to include
                 these additional obligations.

                 4. We agree and have adjusted the financial statistics accordingly. Reports
                 from the RD mission area’s Finance Office show that 19 loans with a total
                 value of $6,825,000 had been obligated in the first half of fiscal year 1998.
                 The draft reviewed by USDA included four additional loans valued at
                 $1,680,000 that had been approved but not obligated in the first half of
                 fiscal year 1998.

                 5. We agree and have adjusted the subsidy cost amount and other
                 appropriate statistics. The draft reviewed by USDA had the subsidy costs
                 that USDA reported in its annual appropriation requests, including
                 $2.6 million for fiscal year 1996.




                 Page 30                                 GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix III
Comments From USDA




6. USDA states that, as more loans are made, the delinquency rate
decreases, implying that the most recent loans are more financially secure.
Our view is that there has simply been less time for delinquencies to occur
on loans made most recently, and the delinquency rate for these loans may
well increase as time passes.

7. USDA states that only a small portion of loans made in recent years has
resulted in losses. It is reasonable to expect a low level of losses on
recently made loans. (See comment 6.)

8. We correctly rounded $148,447,000 as $148.4 million.

9. Differences between the amounts that we present and those suggested
by USDA are due to rounding as stated in the report.




Page 31                                GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix IV

Objectives, Scope, and Methodology


              This appendix contains information on our objectives, scope, and
              methodology in conducting this review. Concerned about the financial
              status of RBS’ business loan programs, the former Chairman of the House
              Committee on Agriculture asked that we report on (1) the number and
              dollar value of loans approved by the agency, (2) the federal government’s
              costs associated with the agency’s loans, and (3) the financial condition of
              the agency’s loan portfolio, including the losses incurred.

              In order to provide relatively current information on RBS’ lending and
              portfolio, we focused on fiscal year 1993 through the first 6 months of
              fiscal 1998; for information on the subsidy and administrative costs of the
              loan programs, we focused on fiscal year 1993 through fiscal 1997 (the
              latest cost information readily available when we conducted our work).

              To compile background information and to gain an understanding of how
              the business loan programs operate, we interviewed numerous RBS
              officials, including the Deputy Administrator for Business Programs, the
              Directors of the Processing and the Servicing Divisions, and the Acting
              Director and a Rural Development Specialist in the Speciality Lenders
              Division. We reviewed the basic statutory authority for the programs—the
              Consolidated Farm and Rural Development Act contains the basic
              statutory authority for the B&I loans; 42 U.S.C. 9812, as amended by the
              Food Security Act of 1985, authorizes the IRP loans; and the Rural
              Electrification Act authorizes the RED loans. We also reviewed RBS’
              implementing regulations and operating instructions, and its various
              publications, pamphlets, and reports that describe the loan programs.
              Additionally, we reviewed USDA’s Budget Explanatory Notes for Committee
              on Appropriations for fiscal years 1995 through 1999. Furthermore, we
              reviewed prior reports addressing the loan programs that were issued by
              USDA’s Office of Inspector General and by us. Finally, we reviewed the
              provisions that apply to RBS and its loan programs that are contained in the
              Federal Crop Insurance Reform and Department of Agriculture
              Reorganization Act of 1994.

              To compile information on the number and dollar amount of loans that RBS
              approved (both direct and guaranteed) during fiscal year 1993 through the
              first half of fiscal 1998, we used RBS’ automated files and its various loan
              reports.

              To compile information on RBS’ estimated subsidy costs and administrative
              costs, we used USDA’s budget explanatory notes. Where information on the
              administrative costs was not available in the notes, we made estimates



              Page 32                                GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix IV
Objectives, Scope, and Methodology




that were based on, for example, reported transfers of funds from the
Rural Development Insurance Fund to RBS or obtained estimates from the
Budget Division in the Rural Development mission area. The descriptive
information on credit reform was extracted from our prior reports. To
compile information on preapplications and applications for guaranteed
B&I loans at the end of fiscal year 1997, we used a report from the Rural
Community Facilities Tracking System, which is an automated information
system used by RBS to manage the loan programs.

Our analysis of the financial conditions of RBS’ portfolio covered fiscal year
1993 through the first half of fiscal 1998. To determine the financial
condition of the three loan programs, we reviewed data contained in RBS’
automated files, the agency’s financial loan reports, and other information
that RBS provided us. We used these data sources to compile information
on the outstanding principal in each program and the portion of
outstanding principal that was owed by delinquent borrowers at the end of
fiscal year 1993 through the first half of fiscal 1998 and the losses that RBS
has incurred during these years. We did not adjust the outstanding loan
amounts to reflect the allowance for losses that RBS includes in its
financial statements nor did we assess the adequacy of reserves on the
loans.

Additionally, to obtain information on borrowers that were not delinquent
but were identified by the agency’s field office officials as being problem
borrowers, we obtained reports from the Rural Community Facilities
Tracking System. We also cross-matched these borrowers with RBS’
automated loan files to determine the outstanding principal owed by each
borrower.

Most of the financial data presented in this report are unaudited
information that we extracted from RBS’ reports and automated records.
We did not verify the accuracy of the information contained in the
agency’s reports and automated records. However, we did cross-match
information in the various automated files that we used, and we also
cross-matched the information we developed with the agency’s financial
loan reports.

We conducted our review from May through October 1998 in accordance
with generally accepted government auditing standards. USDA reviewed a
draft of this report. The Department’s comments are contained in
appendix III.




Page 33                                 GAO/RCED-99-10 RBS’ Rural Business Loans
Appendix V

Major Contributors to This Report


               Charles M. Adams, Assistant Director
               Jerry D. Hall
               Patrick J. Sweeney
               Larry D. Van Sickle




(150745)       Page 34                                GAO/RCED-99-10 RBS’ Rural Business Loans
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